The yields on 10-year government bonds are far lower than the dividend yields of many stocks. This is like the situation that existed until the mid-1950s. We expect government bonds to continue to yield less than stocks, until strong demand for secure bonds abates.

The yields on 10-year government bonds are significantly below the dividend yields on many stocks. The Economist writes: “For investors who started their careers in the 1980s and 1990s, this relationship looks very weird. For them, the norm was for bonds to offer a yield many percentage points higher than that of equities.” Look back further, however, and this situation was considered normal, not weird.

Prior to the mid-1950s, dividend yields from stocks were routinely higher than government bond yields. That’s because investors feared ‘risky’ stocks.

Many investors at that time had lived through the Great Depression of the 1930s. They saw many companies go bankrupt. In such cases, shareholders are the last in line. They can’t receive anything until banks, suppliers, bondholders and preferred shareholders have gotten back all of their money. Common shareholders often lost their entire investment.

Stocks yielded more due to their risks

Companies that survived the Great Depression often found themselves forced to eliminate or reduce their dividends. Remember, companies can pay common share dividends only if they’ve paid creditors all the interest they’re owed—and the full dividends to preferred shareholders.

Prior to the mid 1950s, investors demanded higher dividend yields to compensate them for the risk of owning common stocks. Today’s investors are less fearful of owning a diversified portfolio of high-quality, dividend-paying, stocks.

We believe that it’s all the demand for government bonds that has driven down bond yields. One large source of demand is from central banks. Many are carrying out ‘quantitative easing’. That is, they’re regularly buying large quantities of bonds.

Another large source of demand is from investors seeking safety. Europeans, for instance, are willing to lose a little money by holding bonds issued by creditworthy governments, such as Germany. This beats losing all the money in bonds issued by dodgy governments, such as Greece.

Some think that negative yields can stimulate the economy. The idea is that commercial banks will keep as little cash as possible with central banks, where they’re guaranteed to lose. Instead, commercial banks will lend money to businesses and consumer. At least in this case, they can earn some money.

Negative yields are hard on conservative retirees. Particularly if, as we expect, inflation accelerates in years to come. We believe that you can do better with high-quality companies that raise their dividends year after year.

Bond investors could be hurt by inflation

After the Second World War, Canadians enjoyed a high and rising standard of living. Back then, most of the rest of the world was too poor to buy much. We faced little competition.

In recent decades, hundreds of millions of people have made it into the ‘middle class’ in emerging markets. As a result, we now face more competition. If you try to buy a detached house in Vancouver or Toronto, you’ll have to outbid foreigners, too.

Foreign middle classes will consume more raw materials, food, energy and so on. This will put upwards pressure on prices. That could start a self-perpetuating inflationary cycle, like in the 1970s and 1980s. Bond investors lost huge amounts of money back then. If inflation takes off, we expect that government bond investors will be in for a rude awakening.